Francis Wilks & Jones is regularly instructed to advise lenders in the alternative finance market. This includes Asset Based Lenders (ABLs), platform finance providers and private lenders.
The most important thing to any lender is ensuring that risk is kept to a minimum and that, not only will it get its money back, but that it will also safely grow its money. This brings about some fascinating ideas as to how to best safeguard one’s lend. There are some common threads when it comes to security in theory but case law makes clear that there are some practical considerations to consider too.
Security takes a variety of forms, such as personal and corporate guarantees, mortgages, pledges, promissory notes and charges over business and assets. Invoice finance is a popular form of ABL where the invoice financier funds a company by buying its book debts so that ownership of the debtor ledger passes to the lender.
There is, of course, a distinction between ownership and security. As one can get no better title than outright ownership, it follows that security is taken over assets which belong to borrower or security provider. In invoice finance for example, despite title to the book debts passing to the lender, the reality is that rarely is a ledger fully collectable. Problems can arise with disputed debts and even fraud through what is known as “fresh air invoicing” where fictitious invoices are created and sold to the financier only for the financier to later discover that there is no underlying debt.
In these circumstances the lender would have to look at other means of recovery through its security over the borrower’s assets. These ordinarily are by way of fixed and floating charges over the borrower’s assets.
So what are charges and why are they important?
- Charges are a form of security given to a lender by the borrower over its assets giving the lender priority over other creditors in the event of insolvency.
- Various terms are used when describing charges and a document which contains fixed and floating charges over all the assets of a borrower, is usually referred to as a debenture (or even an all asset debenture).
- Charges do not grant title or ownership to the lender but instead create security rights to the lender over assets which belong to the borrower.
- When the borrower becomes insolvent and the assets are sold, the sale proceeds of assets caught by a fixed charge are paid to the fixed charge holder first, subject only to anyone with a prior ranking fixed charge (one created earlier).
- Fixed charges are created over specific identifiable assets and it is crucial that the charge holder demonstrates actual physical control over the asset so that the borrower is not free to dispose of the asset without the involvement of the lender.
- A floating charge is a charge which is created over (and hovers over) changeable classes of assets rather than specific assets, such as stock where the borrower has ability to use the stock without restriction or perhaps assets not properly caught under a fixed charge.
- Floating charge realisations in insolvency have some disadvantages though as the expenses of the liquidation or administration (including professional fees) are paid from these realisations ahead of the charge holder. A ring-fenced element known as the “prescribed part” also is set aside for unsecured creditors from floating charge realisations.
- The ring-fenced sum is based on the net property (which is the floating charge realisations balance after certain prescribed deductions).
- Where the net property is less than £10,000 – 50% of that property.
- Where the net property exceeds £10,000 – 50% of the first £10,000, plus 20% of the property which exceeds £10,000, up to a maximum prescribed part of £600,000.
- Why have floating charges then?
- They allow the borrower flexibility to trade without restriction (less of an administrative burden to the charge holder too)
- They allow all non-specified assets of the borrower to be swept up so that the charge holder has some (albeit) limited priority over assets which fail to be captured by fixed charges.
- They allow a charge holder to appoint an administrator in the event of default by the borrower through an “out of court” procedure rather than by way of an expensive court application.
- It is therefore crucial for a lender not only to identify specific assets over which it can exercise a fixed charge over but it is also crucial to demonstrate control over that asset. Floating charges are equally important for the reasons above.
Please contact Tim Francis on: tim.francis@franciswilksandjones.co.uk should you have any further queries.
